Do Managers Trade on Public or Private Information? Evidence from Fundamental Valuations

Abstract

Using accounting-based (residual income) valuations, this study examines the extent to which abnormal returns after insider share trades are explained by private information versus mispricing of public information. For a sample of insider trades in the Netherlands (1999)(2000)(2001)(2002)(2003)(2004)(2005)(2006)(2007)(2008), I find that managers' share purchase decisions are associated with positive future abnormal returns as well as equity undervaluation. Even though undervaluation results in predictable price increases, positive abnormal returns following purchases persist after controlling for fundamental valuations. Thus, this study provides evidence on the sources of managers' personal trading gains and suggests that positive abnormal returns after insider share purchases reflect both private information and managers' responses to market mispricing of public information. Keywords: insider trading; mispricing; residual income valuation; private informationThis study is partly based on my dissertation completed at the University of Amsterdam. I appreciate the helpful comments and suggestions from an anonymous reviewer, Joost Impink, and Laurence van Lent (editor). I also thank seminar participants at the University of Amsterdam, the European Accounting Association annual meeting, and the Monash University PhD Accounting and Finance Symposium in Prato for helpful comments on earlier drafts.

Insider Trading and the Patent Application Process

“…We make contributions to at least three distinct literature streams. First, we contribute to the discussion on the sources of insiders' trading profits (Aboody & Lev 2000;Ke et al 2003;Bartov & Mohanram 2004;Ahuja et al 2005;Piotroski & Roulstone 2005;Cheng et al 2007;Cohen et al 2012;Veenman 2012) by documenting that insiders exploit information asymmetries that are generated by the nature of the patent application process. In that respect, this paper is most closely related to studies by Ahuja et al (2005) and Aboody and Lev (2000).…”